Udyam Reclassification: What Changes, and What Does Not, When a Business Outgrows Its MSME Category

A Hyderabad manufacturer closes a good year, files its return, and finds that the Udyam certificate now shows “Medium” instead of “Small”. Its large customers ask whether they can stop treating it as a protected supplier. Its own accounts team asks whether the 45-day payment rule, and the income-tax disallowance linked to it, still apply to invoices already raised.

Short answer. Udyam reclassification follows two tests, investment and turnover, and crossing either one moves the enterprise up. For an upward change, the Ministry of MSME has provided that non-tax benefits of the earlier category continue for three years. Whether that three-year protection also carries Section 43B(h) of the Income-tax Act, 1961 (Section 37(2)(g) of the Income-tax Act, 2025) is not expressly addressed in the sources reviewed, so buyers should proceed cautiously.

Law and scope

• Classification is made under Section 7 of the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act) by notification. The current limits come from S.O. 1364(E) dated 21 March 2025, effective 1 April 2025, amending S.O. 2119(E) dated 26 June 2020 (confirm against the Gazette).
• Payment protection sits in Sections 15 and 16 of the MSMED Act: the buyer must pay within the agreed period, not exceeding 45 days, or within 15 days where there is no written agreement, counted from acceptance or deemed acceptance; delay attracts compound interest with monthly rests at three times the Reserve Bank of India (RBI) notified bank rate (confirm against the Act text).
• Tax disallowance: Section 43B(h) of the Income-tax Act, 1961 was inserted by the Finance Act, 2023. For amounts payable to micro and small enterprises beyond the Section 15 time limit, deduction is allowed only on actual payment. The Ministry of Finance, in a Rajya Sabha reply (Unstarred Question 242, 21 July 2026, as reported), identified Section 37(2)(g) of the Income-tax Act, 2025 as the corresponding provision.
• Which Act applies when. The 1961 Act governs tax years up to financial year 2025-26 (assessment year 2026-27). The 2025 Act applies from 1 April 2026, so financial year 2026-27 is tax year 2026-27 and is read under Section 37(2)(g). Verify the wording of that clause in the Act before relying on it.

Current micro, small and medium classification

Since 1 April 2025 the limits (reported in the notification, and in the Budget 2025-26 announcement released by the Press Information Bureau on 1 February 2025) are:

Category	Investment in plant and machinery or equipment (not more than)	Turnover (not more than)
Micro	Rs 2.5 crore	Rs 10 crore
Small	Rs 25 crore	Rs 100 crore
Medium	Rs 125 crore	Rs 500 crore

The tests are composite. An enterprise that crosses the ceiling for its category on either investment or turnover moves to the next higher category; it does not return to a lower category until it falls within that category’s limits. Investment is linked to the Income-tax Return (ITR), and turnover is linked to the ITR and to GST data under the Central GST Act, 2017, with exports of goods and services excluded from turnover. These Udyam turnover and investment limits replaced the earlier Rs 1/10/50 crore investment and Rs 5/50/250 crore turnover limits. A Press Information Bureau release dated 29 January 2026 refers to a revision of limits but gives no figures; no notification later than S.O. 1364(E) was found, so confirm on msme.gov.in that no further change is in force.

How an enterprise moves up or down

The Udyam portal classifies on the basis of PAN- and GSTIN-linked tax data, so an enterprise’s category can change without a fresh application. Practical points:

• Upward change. As substituted by S.O. 4926(E) dated 18 October 2022, an enterprise “shall continue to avail of all non-tax benefits of the category” it was in before reclassification “for a period of three years from the date of such upward change”. This replaced an earlier one-year period.
• Downward change (reverse graduation). The enterprise continues in its present category till the close of the financial year and takes the lower status only from 1 April of the next year, as reported from clause 8(6) of the 2020 notification.
• Udyam update. The certificate should be updated on the Udyam portal when details such as turnover, investment or activity change. The mechanics of automatic refresh from tax data and the effective date shown on the certificate should be read from the portal itself (confirm).

Effect on MSMED Act Sections 15 and 16

The grace period is described as covering “non-tax benefits”, and delayed-payment protection is among the benefits cited in reports of the notification. A vendor that has moved from Small to Medium may therefore still claim Section 15-16 protection for the three-year period, in the reading most favourable to the vendor. Separately, the Supreme Court held in Gujarat State Civil Supplies Corporation v. Mahakali Foods Pvt. Ltd. (31 October 2022) that supplier status is tested on the date of the contract, so later registration does not operate retrospectively. In NBCC (India) Ltd. v. State of West Bengal (order of 10 January 2025), a two-judge bench observed that registration is not mandatory for invoking Section 18 but referred the question to a larger bench. The outcome of that reference was not located; treat the point as unsettled.

Section 43B(h) after reclassification

Section 43B(h) refers to micro and small enterprises only. A medium-category vendor is outside it. The questions after a vendor moves up are:

1. Is status tested at the time of purchase, at the balance-sheet date, or at payment? The statute and the Ministry reply, as reviewed, do not say expressly (confirm).
2. Does the three-year “non-tax benefits” provision keep a graduating vendor within Section 43B(h)? Section 43B(h) is a tax provision, and the notification speaks of non-tax benefits, so the better view is that it does not extend the tax rule, but there is no authority located on the point. Unsettled.
3. Which date on the certificate governs a supply made close to the change date?

Until these are clarified, a conservative buyer treats supplies made while the vendor was micro or small as covered, and tests each supply by the status on the date it was made.

Worked example (illustrative; all names, dates and amounts assumed)

Assumptions: Buyer Ltd. (financial year April-March) purchases components from Vendor A. Vendor A is shown as Small on Udyam until 31 January 2027 and as Medium from 1 February 2027. Terms: payment within 45 days of acceptance, in writing.

Invoice	Accepted	Vendor status at supply	45-day date	Paid	Position
Rs 40 lakh	20 Jan 2027	Small	5 Mar 2027	25 Jun 2027	Beyond 45 days and unpaid on 31 Mar 2027: deduction deferred to the year of payment under Section 37(2)(g) of the 2025 Act (tax year 2026-27); Section 16 interest exposure continues
Rs 25 lakh	10 Feb 2027	Medium	Not applicable to Section 43B(h)	25 Jun 2027	Outside Section 43B(h); Section 15-16 exposure turns on the three-year non-tax continuation (confirm)

The first row is the safer reading; the second is the unsettled one.

How a buyer should treat a vendor whose status changed

1. Collect the current Udyam certificate and keep a dated history of each vendor’s category.
2. Tag every invoice with the vendor’s category on the date of supply, not only on the balance-sheet date.
3. Treat the 45-day (or 15-day) clock as running from acceptance, and keep the written agreement on file.
4. Do not release “protected supplier” status for three years after an upward change without a documented position.
5. Track dues beyond the permitted period for the Companies Act return on delayed MSE payments (Form MSME-1, half-yearly; confirm current requirement).
6. Review the position again when the vendor’s certificate is updated.

Common mistakes

• Treating the certificate date on file as current when the portal has moved the vendor to a new category.
• Assuming that payment before the due date for the return preserves the deduction. For Section 43B(h) the deduction is linked to payment within the Section 15 limit, so verify this rule against the statute (confirm).
• Assuming that a Medium vendor can never invoke Section 18.
• Overlooking that interest under Section 16 is not allowed as a deduction under the Income-tax Act (Section 23, MSMED Act; confirm).

Hyderabad and Telangana context

Buyers in Hyderabad often source from small units across the surrounding industrial estates. Disputes under Section 18 go to the Micro and Small Enterprise Facilitation Council constituted by the State Government, so Telangana buyers should be aware of the Council’s role. Practices vary by buyer and are not a legal position.

Frequently asked questions

1. Which investment and turnover limits apply now? Micro: Rs 2.5 crore and Rs 10 crore; Small: Rs 25 crore and Rs 100 crore; Medium: Rs 125 crore and Rs 500 crore, effective 1 April 2025. Confirm no later notification.

2. Is the reclassification automatic? The portal uses PAN- and GSTIN-linked tax data; the certificate should still be reviewed and updated (confirm mechanics).

3. What is the grace period? Three years of non-tax benefits from the date of an upward change (S.O. 4926(E), 18 October 2022).

4. Does Section 43B(h) apply to a medium enterprise? No; it covers micro and small enterprises. Whether the three-year provision changes that is unsettled.

5. What is the Income-tax Act, 2025 counterpart? Section 37(2)(g), applicable from tax year 2026-27, as reported from a Ministry of Finance reply of 21 July 2026 (verify in the Act).

Sources and verification

Press Information Bureau releases of 1 February 2025 and 29 January 2026; secondary reports of S.O. 1364(E), S.O. 4926(E) and S.O. 2119(E); Supreme Court reports of the Mahakali Foods and NBCC decisions. Gazette, Udyam portal and India Code pages could not be opened in drafting; verify at msme.gov.in, udyamregistration.gov.in and egazette.gov.in before publication.

Conclusion

Udyam reclassification changes the label quickly, but the legal consequences change at different speeds: payment protection and tax disallowance follow different rules, and the interaction of the three-year continuation with Section 43B(h) is unsettled. A buyer who records each vendor’s category by supply date is best placed to apply whichever view prevails.

Educational purpose only; this is not professional advice. Facts and law may change; consult the notifications and statutes directly.

Arpan Bohra & Co., Chartered Accountants – https://www.arpanbohra.co.in/ – ab@arpanbohra.co.in